What is Fibonacci Retracements?

Fibonacci Retracements

Leonardo Fibonacci is a founder of a simple series of numbers related to the natural proportions of things in the universe. Fibonacci numbers create ratios that arise from the following number series: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144: Calculated this way: 0+1=1, 1+1=2, 1+2=3 and so forth.

The ratio of any number in relevance to the next higher number is 0.618. E.g. 55/89=0.618.There is no need to perform calculation each time you get into a trade, your trading platform is going to do it for you.

Stocks will often pull back or retrace a percentage of the previous move before reversing. These Fibonacci retracements often occur at three levels – 38.2%, 50%, and 61.8%. Actually, the 50% level really does not have anything to do with Fibonacci, but traders use this level because of the tendency of stocks to reverse after retracing half of the previous move. Here is an example using a graphic explaining the retracement pattern…

This picture shows a graphical representation of the reversal points for stocks in an uptrend. The pattern is reversed for stocks that are in downtrends.

After a stock makes a move to the upside (A), it can then retrace a part of that move (B), before moving on again in the desired direction (C). These retracements or pullbacks are what you as a swing trader want to watch for when initiating long or short positions.

Once the stock begins to pull back (retrace), then you can plot these retracement levels on a chart to look for signs of a reversal. You do not automatically buy the stock just because it is at a common retracement level! Wait, and look for candlestick patterns to develop at the 38.2% area. If you do not see any signs of a reversal, then it may go down to the 50% area. Look for a reversal there. You do not know if or when the stock will reverse at a Fibonacci level! You just mark these areas on a chart and wait for signal to go long or short.

How To Place Fibonacci Retracements?

A lot of trader like me wonder how to place Fibonacci Retracement into the chart. Below are some tips.

Straight to the point:

Fibonacci Retracement Levels are:
0.382, 0.500, 0.618 — three the most important levels
Fibonacci retracement levels are used as support and resistance levels.

Fibonacci Extension Levels are:
0.618, 1.000, 1.618 — three the most important levels
Fibonacci extension levels are used as profit taking levels.

So, what we will learn today is how to apply Fibonacci tool 

and how to interpret results 

that we see on the screen.

To set up Fibonacci on the chart we need to find out:
1. Is it uptrend or 

downtrend?2. Highest and lowest swings in the chart 

formation (A, B points).
And go with the trend!

So, click on Fibonacci tool from trading platform that you use. Now, as shown on the Figure below:

We have an uptrend. A — our lowest swing, B — our highest swing. So, we will look to BUY some lots at the good lowest price and go up with the trend. Click on A and drag your cursor to B, click. There you go! You must see different lines appeared on your chart. Those lines are called Fibonacci Retracement and Extension Levels.

So, what we are expecting is next: the price should retrace (go down) from point B to some point C, and then continue up in the direction of the trend. Those three dotted lines (0.618, 0.500, 0.382) at the bottom on our picture shows three Fibonacci retracement levels where we expect the price to take a U-turn and go up again. There we will place our BUY order.

he best situation would be to buy at the lowest level — 0.618 — point C. And on practice the price usually gives us this chance. However, 0.500 is also a good level to place a BUY order.

Well, let's take a look at the progress.

The price has successfully reached the lowest 0.618 point and made a U-turn.

So, now when we have our BUY order placed at desired point C, we would like to set some targets to take our profit in the future. For profit taking levels we use Fibonacci extension levels (0.618, 1.000, 1.618). The most common is 0.618 extension level, but when the price shows good potential to reach next 1.000 or even 1.618 level, you can leave your trade to get that target too. We will choose 0.618 extension level as our profit target, and according to Figure 2, D is our point for taking profit.

Important note: in this Fibonacci tutorial 0.618 extension level (as well as 1.000, 1.618 levels) are calculated in relation to the point B, which means that B point represents a 0% extension.
Some traders like to start counting from point A, then the distance from A to B would be already 100% of the price move. Thus moving further from B would be 1xx.x %.For example: looking at the last picture, if to start counting from point A, then point D would be a 1.618 Fibonacci extension level or a 161.8% of the price move. 

Same steps will also apply to downtrend price movement.

Happy Charting!